Cui Bono: To Whose Benefit?
October 23, 2008

As we survey the wreckage of the global financial system and the seemingly endless bailouts and stopgaps patched together by governments everywhere we should stop and ask: cui bono: who benefits?

We are told, endlessly and even mindlessly, that "we" benefit, somehow and somewhere down the line when everything's better. Meanwhile, back in reality, the benefits to a few are easy to measure: in cold hard cash--$239 billion.

Frequent contributor Albert T. sent in this Bloomberg story which reveals that investment bankers paid out $239 billion in employee compensation even as their stockholders lost $83 billion: Morgan Stanley's Bonuses Get Saved By You and Me:

"Here's all you really need to know to see who lost and who benefited most at the Five Families of Wall Street, otherwise known as Goldman, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns. From the start of their 2004 fiscal years through yesterday, the big standalone investment banks lost about $83 billion of stock-market value. During the same period, they reported about $239 billion of employee-compensation expense.

The Five Families -- now down to just Goldman and Morgan Stanley -- weren't alone. Citigroup Inc., which is getting a $25 billion injection from Treasury, has reported $139.3 billion of compensation expense since the start of 2004, more than double its $62.8 billion of pretax earnings. Its market cap, by comparison, has declined by about $168 billion, to $82 billion.

For all the complaints about outrageous executive pay and how little Paulson is doing to curb it, a big reason why these firms have been scrounging for capital is they keep blowing huge wads of it on their rank-and-file, too. The Paulson plan will do nothing to change that."

As for the supposed benefits of the TARP/Paulson bailout, frequent contributor U. Doran recommended this piece by Jesse over at Jesse's Cafe Americain titled The Safety and Immediacy of Liquid Assets in a Deleveraging Panic. Jesse succinctly captures the essence of the Paulson Plan: by bailing out the bankers, money is supposed to "trickle down" via new lending to the real economy.

But what if the real economy has no need or appetite for more debt? Wouldn't it have been wiser to spend the entire $850 billion (recall Congress added $150 billion in goodies and giveaways) in the real economy, via no-interest student loans, bridge reconstruction, new electrical power lines, etc.?

"The Fed and Treasury approach seems to be to fill the Banks' reserves until they overflow and being to trickle down to the real economy. They believe that they will receive more benefit by placing their capital here because of the power of the fractional reserve money multiplier.
In the short term this may not be fruitful. The engine is seized. Pouring more gasoline in it may not be productive.

Banks need a kick start by a component of the economy that is still functioning normally, if in an impaired manner. That is in the real economy. Rather than reaching the real economy through the banks, the Fed and Treasury might well be more effective in focusing on stimulating real economic activity by stimulating consumption and production directly. Trickle up if you will.
One has to wonder what Keynes would have said about these different approaches to applying stimulus: provide stimulus to the broader public through increases in wages and economic activity, or to provide stimulus to the banks and hope that they will lend to the broader public at rates low enough to stimulate projects that would not otherwise be feasible.

This is a critical point, and little debated or understood as it is emotionally charged with words like 'socialism.' Most do not understand the fractional reserve banking system, but it seems more official, more palatable, to give them billions, enormous sums, and to give the public as little as possible for fear of debasing the value of work and the currency.

Paulson and Bernanke both view the economy as an adjunct to the financial system so from their perspective the choice is obvious.

The Fed and Treasury may succeed eventually in their approach of filling all banks, solvent and insolvent, stable and unstable, until they burst with liquidity and overflow into the broader economy.

In doing so they risk a significant bout of inflation and financial instability that may surprise them."

Cui bono? certainly not the taxpayers or the real economy.

And let's also ask who's benefitting by the dramatic drop in oil prices. Certainly every consumer benefits--or is it more importantly, every potential voter? U. Doran also sent over this intriguing analysis by Gary Dorsch (Sir Charts Alot) entitled Mixing of US Election Politics with Crude Oil which supports the theory that the Saudis and other Gulf oil states have engineered an oversupply of oil to aid McCain's chances for winning the presidency.

As a side-benefit, this oversupply also struck a massive fiscal blow to potential adversaries of the Gulf Oil states: Iran and its allies Venezuela and Russia.

I have previously called attention to the amazing tendency of oil to plummet just before elections; nothing says "go ahead and vote Republican" like a stunning decline in oil and an equally stunning rise in the stock market.

Thus I predict a huge stock market rally between now and election day, and a massive effort by the U.S. and its Gulf Oil allies to suppress the price of gasoline and oil. After the election, then oil will suddenly begin climbing due to "supply and demand issues." Funny how supply ramped up hugely prior to the election and suddenly "shortfalls" will occur after the election.

Do you really reckon The Plunge Protection Team wants Mr. Obama to win the Presidency? Just how hard will they pull the levers to crank down gasoline prices and goose the stock market? As hard as they can, I am sure: cui bono.

We all know who benefitted from the sale of trillions of dollars in CDS and CDO derivatives--investment banks. Now we need to ask who will pay the price. Frequent contributor Craig M. sent along this Bloomberg report: CDO Cuts Show $1 Trillion Corporate-Debt Bets Toxic.
Speaking of derivatives, essayist Zeus Y. has graciously answered reader's followup questions regarding his series of essays on credit default swaps, and provided yet more answers to "to whose benefit?"
Toxic Liabilities Are Not Assets:

Sooner or later we have to recognize a massive fraud has been perpetrated. It needs to be revealed that major companies have trillions of dollars of junk on their books and are likely not solvent according to traditional notions of solvency. So we have a Catch-22, but not one that will be solved by hiding: expose the fraud and risk likely short-term collapse and re-scaling of economic confidence and systems, or cover the symptoms, hide the toxins, and allow them to fester and rot out the economy in a prolonged sickness that may spread and gain momentum beyond attempts to assuage the problems. I highly recommend reading the entire essay, as Zeus lists seven excellent propositions for fixing the fundamental issues.

And for your listening pleasure/amusement: Patriot Express (in disguise) sings Sarah Palin, Queen of the Red party. The lyrics helpfully pop up for your reading pleasure.

Thank you, Cudick A. ($50), for yet another outrageous donation to this site. I am greatly honored by your encouragement, support and readership.

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Grief, Statistics, Culture, Change
October 22, 2008

We have been trained to view statistics as more accurate and "truthful" than narrative, or even what we see with our own eyes. Knowing this, governments fabricate and manipulate statistics through a variety of wily means.

In the Vietnam War, the U.S. desperately needed some metric to measure what was essentially measureless, i.e. the political inauthenticity of the South Vietnamese regime and the ruthlessness and ambition of the North Vietnamese.

So the U.S. established "body count" as the metric of "success" in the war. Once this metric was established, then pressure for "signs of success" led to every civilian killed in bombings and raids (these deaths numbered in the hundreds of thousands) being listed as an enemy combatant to boost the all-important body count.

The American people were still in the thrall of the government's stupendous success in winning World War II and in managing large programs like NASA, and so they naively trusted these nonsensical metrics of "we're winning the war"--until the ferocious Tet Offensive in 1968 blew away all notions that victory was at hand or perhaps even possible in the typical meaning of the word.
Elisabeth Kubler-Ross pioneered an understanding of human grief via this progression of emotional and intellectual processing:

- Shock or Disbelief
- Denial
- Anger
- Bargaining
- Guilt
- Depression
- Acceptance and Hope

Kubler-Ross's stages were: denial, anger, bargaining, depression and acceptance; shock and guilt are certainly applicable to the American public's processing of the Vietnam War: shock that America could "lose" a war; anger at its mismanagement and the leadership that mired the nation in the war; bargaining for "peace with honor" (gag); guilt over the senseless deaths of thousands of Americans and hundreds of thousands of Vietnamese, Cambodians and Laotians; depression over the loss of trust in the U.S. government and the suffering of the wounded/imprisoned, and at least for some, acceptance, and now, hope for better relations between Vietnam and the U.S.

We should be skeptical of all supposedly telling metrics. In the dot-com mania one number could whipsaw the Nasdaq: the "book-to-bill" issued by the semiconductor industry. Does anyone even track this once-mighty stat? I doubt anyone outside the industry even knows what it is now.

We all know how the unemployment numbers are massaged and juiced to reflect a built-in bias towards "growth" and good times": the phony birth-death model, the disappearance of unemployed after they fall off the unemployment office ledgers, etc.

In a similar fashion, we all know official inflation numbers have been manipulated for decades to build in the same bias for "growth" and good times": food and energy were pulled out lest they boost the statistic to uncomfortable levels, etc.

As noted yesterday, official gerrymandering of statistics to create the illusion of growth and prosperity is not a uniquely U.S. phenomenon. From the Wall Street Journal:
China Slows, World Feels the Pain

"Chinese consumer spending has held up well in official figures: Official data on retail sales show them growing 17.9% in September in real terms, up from a 13% to 14% pace earlier this year. But that apparent acceleration is hard to square with outright declines in car sales, down two months in a row after years of double-digit growth, and airline travel, which has decreased every month since May. Sales of major home-furnishing and appliance retailers also are off. Economists suspect actual spending is weaker than the headline figures indicate.

The slowdown highlights how, for all of its show-stopping growth in recent years, China has yet to achieve the kind of scale needed to single-handedly drive the global economy. China ranks 100th in the world in terms of per-capita income, and accounts for 6% of the global economy at market-exchange rates. After adjusting for purchasing-power parity, as many economists favor, China still accounts for only about 10% of the world economy.

China's domestic demand simply isn't big enough to replace the enormous role played by the U.S. While China's 1.3 billion people collectively consumed about $1.2 trillion last year, America's 300 million people consumed $9.7 trillion.

All this statistical legerdemain set the stage for the massive public shock at the depth of our financial problems and the severity of the global recession we are now entering.

There is plenty of denial in official claims that the "slowdown" (heh) will last a quarter or two, but regular folks have burned through denial and are now worried: Turmoil May Make Americans Savers, Worsening `Nasty' Recession (Bloomberg).

Correspondent Bill R. submitted this article by Peter Schiff Just stop paying your mortgage, a bitter reflection of the growing anger that the banking oligarchy is getting bailed out but homeowners with any equity or assets are left twisting slowly in the winds of foreclosure while their irresponsible brethren with no equity or assets are shoveled onto the Federal government via Freddie Mac and Fannie Mae.

We can also detect the outrage in pieces such as this, submitted by correspondent Bill M.: The Idiots Who Rule America (truthdig).

We can also see the bargaining stage at work, as the government desperately tries to stop the deleveraging conflagration sweeping the globe. ("Please, Dark Lords of the Fed and Treasury, grant me this one little favor of $850 billion, and I will mend my ways....") Frequent contributor U. Doran sent in this concise account of the unstoppable blaze by derivatives expert Satyajit Das: De-leveraging – Fairy Tale Endings:

"The "cure" is the reduction of the level of debt (the great "de-leveraging").

The initial phase of the cure is the reduction in debt within the financial system. The overall losses to the financial institutions (net of re-capitalisation via new equity issues) are $400 to $600 billion and may well go higher. This requires reduction in financial sector balance sheets (assuming bank system leverage of around 10 times) of around $4 to $6 trillion through reduction in lending and asset sales.

The second phase of the cure is the higher cost and lower availability of debt to the real economy. This forces corporations to reduce leverage by selling assets, reducing investment and raising equity (for example, as GE has done). This also forces consumers to reduce debt by selling assets (where available) and reducing consumption.

Feedback loops mean reduction in investment and consumption lowers economic activity placing stresses on corporations and individuals setting off defaults that trigger losses for the financial system that further reduces lending capacity. De-leveraging continues through these iterations until overall levels of debt reach a sustainable level determined by lower asset prices and cash flows available to service the debt. The process of destruction echoes W.B. Yeats’ words: "All changed, changed utterly: A terrible beauty is born."

Within the financial sector, de-leveraging is well advanced. In the real economy it is in the early stages.

Fairy tales in financial markets focus on the "superhuman" abilities of regulators and governments to avoid the de-leveraging under way. Central banks and governments have taken progressively more aggressive actions to try to influence events.

At the height of the boom, banks used a variety of techniques to increase the velocity of money. As the system de-leverages, the velocity of money has sharply decreased.

David Roche of Independent Strategy, a consulting firm, estimates that $4 to $5 of debt is now required to generate $1 of economic growth. As credit creation slows and debt levels fall, the sustainable level of global economic growth may fall as well.

Like a giant forest fire the de-leveraging process cannot be extinguished."

We have yet to see much contrition or guilt expressed; that has yet to form. There should be an official recognition of governmental complicity and guilt in this conflagration, and each household which borrowed money irresponsibly must come to terms with their own role in their financial ruin; nobody forced anyone to sign on the dotted line.

We have yet to see real depression, either. I see statistical estimates that unemployment might rise in some "doomsday" scenario from 6% to 9%, and I think, who are they kidding? I have gone on record repeatedly here with an estimate that 30 million of the 135 million jobs in the U.S. will be lost as the velocity of money slows to near-zero and the mass of money rocketing through the system shrinks to a small percentage of its debt-bubble glory.

The emotion of depression is essentially hopelessness, and we are far from experiencing true hopelessness. There will come a time when millions will feel that getting a steady job is hopeless and the notion that their home will rise in value is equally hopeless.
Perhaps around 2012 and the next election cycle, we will collectively be ready to accept the reality of our financial situation and make the changes which would set the groundwork for realistic hope.

One structural flaw shared by any metric is the inability to describe or capture critical cultural differences. If we make a statistical comparison of the U.S. and China, for instance, we are creating a compelling illusion that these two economies can be compared on an apples-to-apples basis.

But the economies of each nation are inextricably bound to their respective cultures. If you know China on the ground, then you may be embarrassed or ashamed by the horrific melamine-in-the-milk scandals, but you are not surprised; counterfeiting, pirating, dilution and adulteration are the norm. This is China's "dirty little secret" which is not discussed except to paper it all over.

The cultures of China, Japan and Korea are bound up with a history of scarcity. While parts of China, Japan and Korea are fertile and rich, many other areas are cold and poor. When people basking in prosperity crowd onto each airplane or train as if it's the last one, that speaks to a profound sense of want and scarcity. When a population follows governmental orders en masse, that speaks to a sense that authority is all that stands between stability and chaos and deprivation.

It can be argued rather effectively, I think, that the cold hard soil of the northeast U.S. nurtured both "Yankee thrift" and "Yankee ingenuity." The desire to escape grinding want is a powerful incentive for both hard work and thrift, and thus it is not a surprise that thrift and hard work are salient features of Chinese, Korean and Japanese cultures.

The Depression generation of Americans were also prodigious savers. When my maternal grandmother passed away in the late 1980s, my sister, my Mom and I went through her belongings and emptied her home. It was a small house, purchased late in life, and the furnishings were similarly modest. As we went through her paperwork, we were suprised to find one savings passbook after another--some six savings accounts, totalling the impressive sum of $100,000. Clearly, my grandparents did not feel secure having all their savings in one institution, nor did they feel secure without approximately four years' living expenses in cold hard cash.

Now that is thrift; in a similar fashion most Japanese, Korean and Chinese families of any means whatsoever maintain large cash savings accounts.

In contrast, Americans now feel that thrift-free prosperity is a birthright. In a subconscious way, Americans knew the dot-com prosperity was not sustainable, and deep down they sensed the housing bubble was likewise unsustainable. But they allowed themselves to believe, just as we sometimes allow ourselves the illusion that we're in love, that housing would enable a work-free, thrift-free, innovation-free, sacrifice-free prosperity.

The conflagration of deleveraging is burning up all the bogus "prosperity" created by a credit bubble without historic precedent. Now we are left with questions: how will each culture/society express their collective anger at this tremendous reversal of fortune? How will the collective guilt for the firestorm be experienced or deflected? How will each culture process acceptance? How will renewed hope be reflected politically?

The answers will unfold only slowly; we have many stages yet to pass through before we can arrive, cleansed of illusion and anger, at acceptance.

Thank you, Josh G. ($20), for your much-appreciated donation to this site. I am greatly honored by your support and readership.

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A 1,000 Foot High Tsunami
October 21, 2008

A topic of much debate is how the recession in the U.S. and Europe will impact China. One camp sees strong domestic growth, investment and government spending as cushioning the inevitable fall in exports; another camp sees thorny structural problems being unmasked by global recession.

Longtime correspondent and frequent contributor Cheryl A. sent in this story China's Growth Slows to 9%, Below Expectations, which linked to this piece in the Far East Economic Review: The Great Crash of China.

The Economist checked in with this update Growth slows in China, as the global economic slump takes its toll (Oct. 20 2008).

Earlier this year, The Economist ran a piece which supports the "decoupling" camp's belief that domestic spending is larger than statistics give it credit for: An old Chinese myth Contrary to popular wisdom, China's rapid growth is not hugely dependent on exports (Jan. 08).
In a recent entry The Coming Destruction of U.S. Bonds (October 3, 2008) I quoted from Henry Paulson's essay in Foreign Affairs, The Right Way to Engage China, as we can probably assume Paulson has access to reasonably accurate data:

One of the most notable indications of China's imbalanced growth is its large current account surplus, which last year amounted to over 11 percent of the country's GDP. This reflects the fact that China spends much less than it produces and earns and that it has a high rate of national saving. Chinese household consumption was only 35 percent of GDP in 2007, down from roughly 50 percent 30 years ago, when Beijing started market reforms. (Household consumption is roughly 70 percent of GDP in the United States and 60 percent in India.)

On the other hand, household savings are high, as individual Chinese try to compensate for the country's thin social safety net, limited options to finance major expenditures such as education, and few investment options other than bank deposits. Demographics will only exacerbate these trends: as China's population ages, the traditional source of support in retirement -- children -- will become increasingly scarce.

(If you'd like some context for China's long-term structural challenges, please read my 2005 report, China: An Interim Report: Its Economy, Ecology and Future .)

Let's stipulate a few points before we begin any analysis:

1. Statistics on China are not entirely reliable for a number of reasons. (Cheryl A. sent along a comment made by Marc Faber in an interview with Bloomberg dated Oct. 20. 2008, along the lines that one thing China learned from the U.S. is how to doctor economic data. He doesn't believe the 9% growth number and says China will be lucky to have an annual growth of 5%.)
2. There is a long lead time in exports, hence any impact of the Western meltdown is still ahead.
3. "reports from the ground" in China provide nuance and context which is missing from statistic-only analysis/opinion.

With those points in mind, here is a report filed a week ago from a good friend of ours, a Chinese native who has traveled widely in the West and has split her time between China and the U.S. for many years. Our friend did not grow up in an elite but worked her way up like everyone else via education and hard work:

"No matter whom we talked to these days, the topics were all related to the financial and economic situation in the U.S. They seem to follow what's going on in the U.S. very closely. They believe that the many complicated products recently developed by those banks, and the U.S. government not doing a good job in monitoring those banks caused the financial problems in the U.S.

According to the newspaper and internet messages here, almost all ordinary Chinese people object to putting more money in the U.S. to help rescue the mess there. I don't think the Chinese government is eager to help out either. However, they all realize that the slow economy in the U.S. is going to affect China's export business, and hence the factories and other related sectors. On the other hand, they also believe that the Chinese products which have been sold in the U.S. are mostly daily necessities of ordinary American people, not luxury products that you can live without in a slow economy. So they think the weak buying power of American people will affect European products more than Chinese products.

The economy here seems fine, although my friends as well as my father did complain about the weak stock market. But you don't feel the panic here at all, people still have their stable jobs and incomes, and even those who have lots of money tied up in the stock market have large deposits in the bank. Most people we talked to own at least one or two apartments (some houses), and are all paid off. So they hardly have any expense, except food, clothing and gas.

I won't say people here are taking pleasure in other people's misfortune in this regard. But you do have a feeling that America/Americans' image is significantly declining."

Put this all together and I think a 1,000 foot high tsunami is heading for the shores of both China and the U.S.

Let's start with the wave heading for the U.S. Given our correspondent's report (as well as many other online reports), we can anticipate a rising political pressure within China to spend its surpluses on domestic development.

The enormous need for infrastructure and additional education in China's vast rural interior is beautifully illustrated by this remarkable 1999 film Not One Less .

If the Chinese central government shifts its export-created surpluses to domestic spending, the big loser will be U.S. bonds and debt. Here is my oft-published chart of the U.S. bond yield and the staggering rise in Chinese ownership of U.S. debt:

What this chart illustrates is that the only reason interest rates haven't skyrocketed along with rising U.S. debt is that China and other non-U.S. players with hundreds of billions of trade-surplus dollars have been soaking up that debt (bonds) with their dollars.

This can be seen as manipulation for the benefit of oil exporters and Asian exporters equally anxious to prop up American consumers with low interest rates, or as intervention to keep their currencies lower than the dollar, or as a combination of manipulation/intervention and "safe haven" parking of stupendous hordes of dollars.

Regardless of the perspective, one thing is clear: as soon as that foreign buying declines, U.S. interest rates will start rising.

Rising rates as the U.S. attempts to borrow-and-spend its way out of a deep recession via stupendous deficits of $1 trillion or more a year is a 1,000 foot high tsunami which will wash over housing (rising mortgage rates) and government spending (more money will be diverted to paying interest on old and new debt).

Some readers have suggested that domestic savings will start pouring into Treasuries as Chinese investment in T-bills recedes (you know how the tide seems to ebb just before the tsunami hits), and I agree some domestic savings will flow into "safe" T-bills. But the question is: will enough flow in to keep rates low?

There are three big problems with this scenario:

1. domestic savings rates are still very low, and it is quite a stretch to anticipate the U.S. saving $1 trillion a year and putting it all in T-bills.
2. the yields on T-bills are so low now that they are only appealing in times of panic/crisis; as soon as that fades, investors will seek better returns just as they always have.
3. As recession guts U.S. household incomes, then people may find they have less to save even as they slash household spending.
Ironically, the biggest incentive to more domestic purchase of T-bills would be a much higher yield--a condition I think we're going to get regardless of what the Fed does with the Fed Funds rate.

I think the 1,000 foot high tsunami heading for China is made of many smaller waves coming together:

1. The idea that investment in steel mills, shopping malls and commercial real estate will continue unabated during a deep recession/depression in the U.S. and Europe is suspect. China now faces over-capacity in virtually every industry, domestic and export alike. As I have noted here many times, over-capacity in domestic TV production has been an issue since early 2000; now the same over-capacity can be found in autos, steel, cell phones, etc.

Stories of nearly empty giant shopping malls are filtering in; a gigantic over-building of commercial and retail space in China has taken place and those bubbles are about to burst.
2. Retail sales rose 22% nominally, but inflation accounts for some of that rise; and with exports having a long built-in lead time, the effects on household income from a declining export sector have yet to be fully realised.

Add in the inevitable collapse of real estate overdevelopment and construction, and you get a significant drag on retail sales.

3. Complacency is the enemy of good judgment. If there is a single word to describe the fall of the U.S. financial empire and economy, it would be a tough battle between hubris and complacency. Our friend's report suggests complacency is running very high in China now; the successes of the Olympics and the space flight and the demise of the U.S. financial house of cards are clearly creating a rosy glow of confidence/complacency that the effects on China will be minimal.

That sets up brittle expectations which are vulnerable to shattering. Our friend's report reveals a faith that the U.S. consumer will still be buying Chinese exports regardless of recession; while this is undoubtedly true to some degree, it is also true that the U.S. is literally awash with too much of everything. Once people start opening up their millions of storage lockers and selling the contents for a few cents on the dollar, the demand for "new" will be considerably less.

4. China has its own lending/debt bubble. It's difficult to sort out how much easy money is sloshing around China looking for a home, but it is certainly in the hundreds of billions of dollars--much of which has now been mal-invested in empty malls, factories making stuff nobody's buying, municipal sports complexes which generate no revenues, etc.

Will China weather a global recession? Of course; Chinese people are used to hardship, many families have large savings and as our friend noted, most households have little or no debt. Those are huge advantages in any economy. But at least to this observer, an "impossible" drop from +10% GDP growth to -1% GDP decline is already baked in by the upcoming collapse of exports and direct foreign investment and the consequences of mal-investing much of the past decade's surpluses in projects with little or no positive return (empty malls, sports complexes, etc.).
There will be plenty of Chinese ghost towns, too, just as there are so many overbuilt, mal-investment ghost towns in the U.S. The tsunami is traveling from the center toward both East and West, and the consequences will last for quite some time.

Bonus "it's a small world" story:
I haven't mentioned that Obama and I graduated from the same private prep school in Honolulu. I don't think this alumni connection taints my analytic skepticism too greatly, but I do have a soft spot for Obama's Hawaii connections, which I believe are more profound than most Mainlanders can understand.

I recently discovered some of my old Lanai High School teammates scrimmaged with Obama after-hours on the Punahou basketball courts; here is my report, graciously posted on Ian Lind's widely read and highly respected Ka'a'awa-based blog ilind.net--The Obama-Lanai Connection.

Put this in the "Dis stay one small-kine world" file.... And for your listening
pleasure/amusement: Patriot Express (in disguise) sings Sarah Palin, Queen of the Red party. The lyrics helpfully pop up for your reading pleasure.

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It's Different This Time: Housing, Deflation and Depression
October 20, 2008

Now that the economy is careening from a systemic financial meltdown into depression, it is easy pundit pickings to "compare and contrast" this depression with the Great Depression of the 30s and with the Stagflation of the 70s.

We've all seen a number of these analyses, and I have yet to find one which illuminates housing's quite different characteristics in the deflationary 30s, the inflationary 70s and the present. Here is my attempt to draw distinctions between those past depressions and the one we are now entering.

Why single out housing? For the simple reason it is the primary reservoir of both psychological and "real" wealth (i.e. assets as measured in constant dollars or purchasing-power parity.)

When housing plummets in real value, 2/3 of the nation (those who own homes) both feels poorer (the "reverse wealth effect") and is measurably poorer in terms of assets owned.
Let's start by assessing "what's different" and "what's similar."

Huge number of charts today--please go to www.oftwominds.com/blog.html to see them all.

1. Home ownership in 1930s was about 45%; the majority of citizens were renters/tenants. After the war the advent of low-down, low-interest FHA and VA (Veterans Administration) affordable mortgages fueled a sharp rise in homeownership which raised the rate to 60% by the late 50s. At that point the rate plateau'd and slowly rose to 65% by the late 70s.

This tremendous rise in the "ownership society" reflected three postwar positives: booming economy which created millions of middle-class income jobs, cheap plentiful domestic oil and cheap, plentiful Federally backed mortgages. Basically, everyone who could afford a home was able to buy one.

2. Inflation and house prices rose in tandem in the staflationary 70s. Here we see just how steeply inflation ran up in the 70s:

Adjusted for inflation, the rise in housing was rather modest and well within historical norms, despite soaring nominal prices.

3. By two other measures of relative value--comparable rents and percentage of income--housing values remained relatively stable in the decades prior to the current bubble/bust.
One standard way to measure housing prices is to compare them to the cost of renting comparable houses over time:

By this measure, we can see that houses did rise about 10% in the high-inflation late 70s, only to fall back 10% in the recessionary early 80s. The subsequent "mini-bubble" of housing values in the late 1980s registered less than a 10% rise, suggesting the increase was actually less than the bump up in the late 70s.

Another valuable yardstick is to measure housing as a percentage of disposable income:

Here we see that in terms of income housing fluctuated within a modest band from 1955 to 1977. From about tne mid-70s, U.S. houshold income stagnated and as a result housing jumped as a percentage of income, breaking out of the historic range. The "mini-bubble" of the late 80s pushed housing up about 1/3 above historic norms.

In the slowdown/recession of the early 1990s, housing as a percentage of income fell back to roughly the same level as 1980 as houses dropped in value and the tech boom of the 1990s modestly increased family incomes. This chart suggests that housing had leaped in relative value to a new range around 140, even as the cost-to-buy/rent ratio (chart above) returned to the 1975 range.

4. Around 2001, housing burst through all historic ranges of value and shot up in a parabolic/exponential ascent. The bubble is clearly visible in the two charts above as well as this one:

The extraordinary nature of this bubble is also revealed by charting New Homes For Sale:

5. Beneath the surface of the credit/housing bubble, two disturbing trends were visible: a slow decline in savings and a stunning rise in mortgage debt. The charts tell the story:

Even as housing shot up in the late 1980s in a "mini-bubble," personal savings fell below its historic range and then plummeted from 8% of disposable income in the early 1990s to minus 1% at the peak of the housing bubble 2005-2007.
Even as savings dropped to negative numbers, mortgage debt was quadrupling from 1990 to 2007:

As an unprecedented credit bubble of low-interest liquidity fed a speculative fever in all three asset classes, stocks, bonds and housing, household wealth shot up $20 trillion from the 2002 stock market nadir to the housing-bubble peak in 2006.

The stock market's recent 40% has erased much of the equity gains of the 2002-07 period as well; combining the trillions in lost housing value with the trillions lost in global stock markets, we can see that most if not yet all of household wealth gain 2002-06 has been surrendered.

Alas, parabolic bubbles eventually return to the mean via steep declines, as this chart illustrates:
So what can we conclude about the current depression and housing?

1. Ironically, the postwar rise in home ownership means the stunning decline in housing wealth affects 2/3 of all households rather than the 1930s-era 45%.
2. Rising housing values effectively masked the stagnation in household incomes for the past 25 years; now with housing returning to historic valuations, the stagnation of real income is starkly revealed.
3. Housing has a long way yet to fall to return to historic measures of valuation based on comparable rents and as a percentage of disposable income.
4. The main difference between past depressions and the current one is we are far more indebted now--both nominally and when adjusted for inflation.
5. Income stagnation is now coupled with asset deflation, effectively reducing household net worth.
6. The decline in housing value has effectively rendered housing a Capital Trap as "won't sell" becomes "can't sell":

The growing dependence of the U.S. household on rising housing values to offset declining income has now reversed into a debt serfdom in which any remaining capital/net worth left in housing is effectively trapped.

All this suggests that calls for a "bottom in housing" in 2009 or even 2010 are optimistic.

Bonus "it's a small world" story:

I haven't mentioned that Obama and I graduated from the same private prep school in Honolulu. I don't think this alumni connection taints my analytic skepticism too greatly, but I do have a soft spot for Obama's Hawaii connections, which I believe are more profound than most Mainlanders can understand.

I recently discovered some of my old Lanai High School teammates scrimmaged with Obama after-hours on the Punahou basketball courts; here is my report, graciously posted on Ian Lind's widely read and highly respected Ka'a'awa-based blog ilind.net--The Obama-Lanai Connection. Put this in the "Dis stay one small-kine world" file....

Thank you, Eugenio M. ($15), for continuing generosity to this site and for your many contributions of resources and topics. I am greatly honored by your support and readership.

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Socializing, Sharing and Learning: The Web's Leverage Points

In pondering leverage points for positive change, the Web dominates my thinking precisely because it offers our highly social, highly curious species new ways to socialize and explore.
At the risk of sounding entirely unpolitically correct, I would say the natural, ideal scenario for the average human being is not building a temple, pyramid, fortress or palace but lazing around under a shade tree with other humans, gossiping and making jokes--often at someone else's expense.

If that seems too timid and obvious to be un-PC, then how about this: the only activities which really rouse the blood of human males are:

1. killing something which is good to eat, but if not, killing something just for fun
2. starting a fire or otherwise destroying stuff
3. going fast, climbing high, etc. (yes, the space shuttle can be counted twice)
4. seeing what's going on in the next valley (prospects of danger, violence or easy pickings make it ever more attractive)
5. acquiring easy wealth or social status which can be translated into access to desirable females 6. playing some sort of game or equivalent "guys in the treehouse" activity which either offers hope of raising one's social status or at least strengthens bonds to the Leaders of the Pack, i.e. maintains current social status
7. learning/acquiring something which offers a competitive advantage in terms of wealth (mating prospects) or social status (mating prospects), preferably without requiring too much work (i.e. credit default swaps, flipping real estate, etc.)

Human females of course are also adventurous, curious and interested in raising wealth and social status; but while the guys in the treehouse are either daring each other to swim Turtle Creek or attempting to make homebrew out of juice, sap, crushed leaves, etc., under the tree the conversation drifts to essentials such as, who's hooking up with whom, who just broke up, who's pregnant, whatever happened to him/her, and what's up with the local leaders/celebrities.

Unsurprisingly, the Web offers opportunities for all of the above, mostly vicariously. The attractions of socializing, gossiping and networking are essentially human nature distilled to its essence.

That may seem trivial as we face the unprecedented challenges ahead (blah blah blah), but building trust and sharing successful strategies are perhaps the motivations behind the development of both spoken and written language/codes.

There are downsides, of course, to the Web. This is, after all, real life and not a game, so there are always non-trivial tradeoffs. Perhaps the most obvious--and despite this, perhaps the most profound--downside is the atrophying of actual real-live human socializing (e.g. bowling alone, few cook real food any more, etc.) in favor of its online simulacrum, and in the physical atrophying of action in the real world in favor of mouse-clicks and joystick manipulation.

I know many of you are like me, and you run out of patience for the screen after a few hours so you turn it off and go on a bicycle ride or do something in the real world with your physical being--pull weeds, water the roses, pluck some beans from the vines, try to fix that stupid vacuum cleaner whine, etc.

Although I haven't found any definitive study on this, clearly our brain chemistry/ activity is changed by watching TV or films, and changed in somewhat different ways by web-surfing, emailing, etc. It seems likely these changes are not net-net positive for our mental or physical health.

Rather like the old Woody Allen comedy in which cream puffs were discovered to be good for you, I would be quite surprised if living online 8 hours a day turns out to be wonderful for our mental and physical health.

A more subtle and therefore more pernicious downside is the flattening of knowledge by the simulacrum of "information." In one of my very first entries on this blog Flattening the Knowledge Curve: The "Googling" Effect (May 2005) (back when it had 30 visitors on a good day rather than 10,000), I suggested that Googling and the wealth of short segments of expertise/knowledge offered up by searches created an illusion of comprehensive knowledge--what we might call "working knowledge." This superficial "wealth" is actually a simulacrum of "the real thing" which can only be gathered by the reading of lengthy, contextually rich, coherently organized books or by experience in the real world.

As a free-lance journalist, I learned the necessity of background knowledge or context; but I also learned how easy it was to simulate an understanding of complex topics by eliciting the requisite "three quotes" from "experts" or "man/woman on the street" sources.

The Web thus offers up a tempting simulation of actual working knowledge. It's all too easy to read a few articles and then feel the comfort of having learned something valuable; in a university course, this is standard in introductory classes. But the overview and the excerpts are followed by book-length readings which provide the background needed for analytic or working skills.

For instance: energy is undoubtedly the key issue facing humanity as petroleum enters depletion. Without some grounding in the basics of oil geology and refining, I am doubtful that anyone can summon the necessary skepticism for pie-in-the-sky fantasies like offshore drilling or shale oil. Yes, those may well provide some petroleum in quantity but the numbers just don't add up: the U.S. burns 19.5 million barrels a day (down from 21 MBD a year ago) and the world consumes about 85 MBD. So adding 2 MBD is nice but it isn't going to make Peak Oil go away.
This is why I try to recommend books. Not everyone has time or interest to read a book or two on a subject, but we as a society/civilization have to be very careful not to confuse a mass of information with context-rich knowledge.

I don't claim to be an expert in Peak Oil (or anything else, for that matter) but I reckon these books offer a decent orientation to the issues:
The Future of Life
Beyond Oil: The View from Hubbert's Peak
The Party's Over: Oil, War and the Fate of Industrial Societies
The End of Oil: On the Edge of a Perilous New World
Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy
The Long Emergency: Surviving the End of Oil, Climate Change, and Other Converging Catastrophes of the Twenty-First Century
The Solar Economy: Renewable Energy for a Sustainable Global Future

If you already have a deep knowledge base, then the Web is an astonishing resource. If you already know your way around Windows, for instance, all the fixes and hacks available online will be extremely useful. In trying to repair a friend's buggy Windoz machine (I know, a hopeless task), I couldn't figure out how to force the boot menu with Safe Mode to load on startup. A quick web search provided the answer.

But a novice would have been flummoxed by the instructions. We all know this, because we're all novices in many things. Take auto mechanics. I am undoubtedly one of the world's worst, most talentless mechanics, but I had to swap out a sensor in my Honda engine and online resources explained how to do it in a few lines of text. With this, I was able to go rent the tool from Kragen (free if you bought the sensor there) and get the job done.

But if you've never opened the hood of a vehicle or messed with wrenches, you would be hard-pressed indeed to use the "knowledge" that the web provided. The same can be said of cooking; without some real-world experience, a recipe is only an outline, not instruction.

These are just three of countless examples. Information is not knowledge, yet the Web offers a seductive confusion of the two.

This is also true of fiction. I really don't think a wikipedia entry or a few online articles can render or bring alive the slums of 19th century Paris as well as Emile Zola managed in L'Assommoir.

Speaking of fiction, it seems like a good time for another shameless self-promotional plug: I am constantly taking a stab at fiction, both stories and novels; here is a sampling:

How I Fell in Love with a Homeless Woman
"I can faithfully report that one falls in love with a homeless woman in the same manner as one falls in love with any other woman: your eyes meet, and some spark passes between you which is beyond easy description."

If, despite your better judgment, you are curious, there's more:
Novels and free first chapters
Adventures of Daz and Alex
A Few More Stories

Thank you, Joseph B. ($20), for your much-appreciated generous donation to this site. I am greatly honored by your ongoing support and readership.

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